Weekly market & economic update
Current economic events
Week of December 2, 2019
The global economy may be improving from a recent economic trough. Emerging markets have led this budding strength, despite the struggles of developed economies. Emerging Asia has been at the vanguard, with our proprietary economic “Health Checks” measuring Chinese, South Korean and Taiwanese data all reaching seven-month highs. Developed markets, from the United States to Europe and Japan, have shown fewer green shoots; all are still barely off their Heath Check lows and remain in downtrends. On the policy front, disputes over United States/China trade have eased and investors’ confidence in a potential “phase one” deal increased. Even so, negotiations continue on this deal, but President Trump’s signing of the Hong Kong Human Rights and Democracy Act — and China’s promise of retribution for its passage — may complicate proceedings. Multiple Federal Reserve (Fed) members, including Chair Jerome Powell, expressed optimism about the health of the economy last week. Powell noted that he sees the proverbial glass as “much more than half full.” This positive outlook may reduce the chances of interest rate cuts soon, though the Fed’s continued commitment to the elusive 2 percent inflation target means that a patient stance appears more likely than outright rate increases. Momentum in our global economic Health Check has reached its highest level since mid-2017, though we’ll need to see follow through from developed economies before we can declare the global slowdown definitively over.
In the holiday-shortened week, U.S. data pointed in conflicting directions. U.S. third quarter gross domestic product (GDP) growth was revised higher on larger business inventories than originally measured. However, data from the current quarter is somewhat disappointing with one month to go. Survey data for October from the Chicago Fed and the Chicago Business Barometer weakened and specific survey questions provided a signal of a weaker jobs market ahead. Orders for core capital goods were flat in October and the indicator continues to contract relative to a year ago. Growth in October personal consumption expenditures (PCE), which makes up a substantial portion of GDP, fell to its weakest point since December 2018. The core PCE deflator, which the Fed prefers to measure inflation, continued to soften and remains below the central bank’s 2 percent target. Housing data continues to show strength, reflecting the decline in mortgage rates; new home sales are growing at the fastest pace since 2013 and home prices grew faster for the first time since early 2018. Our U.S. economic Health Check has risen to its best level since August, though overall trends remain firmly negative.
Foreign developed economies have struggled to move more than modestly off their economic lows. Eurozone economic confidence, which is highly correlated to GDP growth, posted one of its best improvements in two years in November, with consumer, services and industrial confidence all picking up. One blemish on the otherwise solid report was in the manufacturing-focused business climate indicator, which fell back to its lows since 2013. Eurozone headline and core consumer price inflation (CPI) picked up sharply in November but remain well below the European Central Bank’s “near 2 percent” target. The unemployment rate ticked back down to match its lowest level since July 2008. October hard data in Japan was very weak, with consumption tax hikes taking effect. Industrial production growth fell to its worst rate since at least 2013 while retail sales growth contracted the fastest since January 2015. Housing starts also contracted at the quickest pace since May. November survey data has shown improvement, including a sharp rise in consumer confidence, so next month’s hard data may be less dire. Our foreign developed economic Health Check remains near its lowest point since late-2014 and in a downtrend.
Emerging economies have shown pockets of strength lately. Mexico narrowly moved out of recession in the third quarter for the first time in a year. South Korean consumer confidence rose to its best level since April, though industrial production fell back into contraction during the month. Korean retail sales growth also slowed in October. Next week’s November global purchasing manager’s indexes (PMIs) will give us more information about whether the burgeoning strength continued this month. Our emerging market economic Health Check has reached an eight-month high and regained an uptrend for the first time since January 2018.
The performance of U.S. equities remains superb. As the market inches higher, the pace of consumer holiday spending is likely to impact equity prices into year-end. On balance, restrained inflation, low interest rates, moderate earnings growth and a lack of widespread euphoria are providing valuation support and the basis for stocks to trend higher.
The S&P 500 reached another record high of 3,153 on November 27 before closing the week fractionally lower. Wednesday’s record high was the 26th time the index reached new highs this year, indicative of strong price momentum. With a 25.3 percent gain as of Friday’s close, year-to-date performance is nearly double the historical average, aided by benign inflation, a dovish Fed and modest earnings growth. All 11 S&P 500 sectors are up for the 12 months ending November 30, with nine of 11 sectors up 15 percent or greater, led by Information Technology, Communication Services and Industrials. The recent strong performance of Healthcare is a standout; it is the best-performing sector quarter-to-date, increasing 10.1 percent, with no discernible catalyst. The sector has lagged for much of 2019 due to “Medicare for All” discussions in Washington. Relative valuation and reversion-to-the-mean tendencies may partially explain the recent strength. Energy continues to lag, as it did in 2018, up a mere 1.7 percent as of the end of November. Oversupply and lingering trade tensions between the United States and China continue to weigh on the sector.
November performance was superb, with growth/cyclicals outpacing defensive sectors. The S&P 500 advanced 3.4 percent for the month, with nine of 11 sectors posting gains. During November:
- The Information Technology, Financials, Healthcare and Industrials sectors led the way, all advancing 4.1 percent or greater during the month.
- The interest-sensitive Real Estate and Utilities sectors were the worst performers, retreating 2.0 and 2.3 percent, respectively. This suggests that valuations for many companies within these sectors may be stretched.
- The strong performance of Information Technology (year-to-date and in November) is largely driven by software companies associated with artificial intelligence and machine learning. We expect these secular trends to continue into the new year and beyond.
Consumer holiday spending, employment data and Fed comments are likely to be factors most significantly impacting equity prices into year end. With the holiday spending season just beginning, it’s too early to have a good read on the pace of spending. The record-high stock market, low unemployment rate and overall favorable sentiment are among reasons to expect spending this holiday season to meet or exceed expectations. Looming on the horizon are generally high inventory levels, spurred by companies buying ahead of December 15 when the 10 percent tariff level is set to kick in on select consumer goods imported from China. High inventory levels imply potential margin pressure should sales not materialize forcing companies to discount merchandise at year-end. Meanwhile, November employment report released this week will provide updates on unemployment levels and average hourly wage gains. A positive jobs report typically boosts sentiment along with equity prices — both components of a favorable backdrop for holiday spending. Finally, the Federal Reserve Open Market Committee meeting and subsequent statement scheduled for December 10-11 will provide an update of the assessed pace of economic growth and inflation as seen through the lens of the Fed. In our view, U.S. equities are likely to trend upward for as long as the Fed maintains its dovish bias.
Our published year-end 2019 price target for the S&P 500 remains unchanged at 3,135, fractionally below current levels and toward the upper end of our predicted range. Our single-point year-end 2020 price target is 3,325 (19 times earnings of $175 per share), approximately 6 percent above current levels.
Fixed income markets
It was a quiet week across fixed income markets last week, with Treasury yields finishing the week mostly unchanged from the previous Friday. Longer-term yields rose early in the week on stronger-than-expected data out of China. The Treasury curve has only a slightly positive slope, which limits the amount of incremental yield investors receive by extending maturities. Long-term Treasury yields have been held down by expectations of tepid growth and inflation in the United States and abroad. Weak inflation supports the Fed’s patient stance of an easing bias toward monetary policy. Economic data will be heavy this week, with PMI, sentiment and payroll data scheduled for release. We recommend investors in taxable bonds hold portfolios with slightly below-benchmark duration, because there is little opportunity to find extra yield by extending to longer maturities. Municipal bond investors, on the other hand, should maintain portfolios with duration profiles slightly longer than benchmarks due to the steeper curve in that market and resulting incremental tax-equivalent yields available.
Corporate bond spreads (yields compared to Treasuries) finished the week slightly tighter. Positive investor sentiment continues to hold spreads below historic medians. We believe spreads can remain tight for some time, but worsening credit fundamentals present a larger risk than usual among lower-rated bonds. We recommend investors hold primarily high-quality investment-grade bonds, given somewhat deteriorating fundamentals, particularly elevated corporate debt levels. This serves to offset some risk from more volatile holdings with higher expected returns, like stocks.
Crude oil prices, as represented by West Texas Intermediate, were down 4.5 percent last week, but are still up 22 percent for the year. Domestic fundamentals were negative for prices, with inventories increasing across the entire crude oil complex — including refined products — while production ticked higher to another all-time high. Additionally, Saudi Arabia seemed to allow some flexibility on the current Organization of the Petroleum Exporting Countries (OPEC) production cut agreement, which created worries of oversupply. All eyes will be on the OPEC meeting this week to see if the production cut agreement is extended. If it doesn’t, prices will likely reset lower.
The gold market was flat last week, and for the year prices are up 15 percent. Gold prices eased recently as interest rates moved higher and the volume of negatively yielding debt declined. However, central banks engaging in balance sheet expansion policies have been a catalyst for higher gold prices in the past. With more than $12 trillion in negative yielding fixed income securities across the globe, precious metals have an advantage over a large swath of the bond market. Prices can remain supported in a higher rate environment as global central banks fire up their bond buying programs and investors look for protection from currencies not backed by a commodity.
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This information represents the opinion of U.S. Bank Wealth Management. The views are subject to change at any time based on market or other conditions and are current as of the date indicated on the materials. This is not intended to be a forecast of future events or guarantee of future results. It is not intended to provide specific advice or to be construed as an offering of securities or recommendation to invest. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Not a representation or solicitation or an offer to sell/buy any security. Investors should consult with their investment professional for advice concerning their particular situation. The factual information provided has been obtained from sources believed to be reliable, but is not guaranteed as to accuracy or completeness. U.S. Bank is not affiliated or associated with any organizations mentioned.
Based on our strategic approach to creating diversified portfolios, guidelines are in place concerning the construction of portfolios and how investments should be allocated to specific asset classes based on client goals, objectives and tolerance for risk. Not all recommended asset classes will be suitable for every portfolio. Diversification and asset allocation do not guarantee returns or protect against losses.
Past performance is no guarantee of future results. All performance data, while obtained from sources deemed to be reliable, are not guaranteed for accuracy. Indexes shown are unmanaged and are not available for direct investment. The S&P 500 Index consists of 500 widely traded stocks that are considered to represent the performance of the U.S. stock market in general.
Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. International investing involves special risks, including foreign taxation, currency risks, risks associated with possible differences in financial standards and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility. Investing in fixed income securities are subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Investment in debt securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term debt securities. Investments in lower-rated and non-rated securities present a greater risk of loss to principal and interest than higher-rated securities. The municipal bond market is volatile and can be significantly affected by adverse tax, legislative or political changes and the financial condition of the issues of municipal securities. Interest rate increases can cause the price of a bond to decrease. Income on municipal bonds is free from federal taxes, but may be subject to the federal alternative minimum tax (AMT), state and local taxes. There are special risks associated with investments in real assets such as commodities and real estate securities. For commodities, risks may include market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes and the impact of adverse political or financial factors. Investments in real estate securities can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, changes in interest rates and risks related to renting properties (such as rental defaults).
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